Posts Tagged ‘cisco’

Sorry I have been so silent lately on this blog. I have been heads down collaborating on a new book titled B4B. The historical business models of technology providers are imploding in front of our eyes–and this is why we needed to write this book. What do the new business models look like for traditional hardware and software companies?

Meanwhile, the real world examples of how the concepts outlined in B4B just keep popping. Cisco has always had an economic engine centered on product revenues and margins. As we discuss in B4B, that economic engine is commoditizing. Companies like Cisco will need to transition their economic engines. And the transitions have begun:

The move reflects two stated priorities of Cisco CEO John Chambers: to bolster Cisco’s overall security business and to rapidly expand Cisco Services operation in an effort to become the world’s largest IT company. In other words, Chambers wants to transform Cisco into an IBM with networking roots.

The problem, however, is that Cisco (or any other hardware company) doesn’t really want to become another IBM. Have you looked at IBM’s top line growth numbers lately? No, product companies like Cisco need to become something very different than what IBM is today. And that is why we wrote the book. Can’t wait for Vegas.

First entry of the New Year. Typically, these things are bouncy and optimistic. This time of year, everyone has that “clean desk” mentality. Anything is possible. Unfortunately, I am just not feeling it as the technology sector enters into 2012 In fact, I have a foreboding feeling inside.

The Potential of 2011

Way back in 2009 and 2010, when many sectors were reeling from the global downturn, the tech industry was navigating the stormy seas rather well. Yes, product revenues were down. But service revenues were holding and profits were actually increasing. By the beginning of 2011, product revenues were once again growing and it appeared the tech industry was poised for a wonderful year. But it never came to be.

he Realities of 2011

By the time we took the Q3 2011 snapshot of the TSIA Service 50, it was clear the tech industry was not enjoying the best of years. Every quarter, we compare service margins, product margins, and operating incomes from the same quarter the previous year. The graph below from the Q3 snapshot documents a very humdrum 2011 for the tech companies in the index.

More specifically, some of the market leaders demonstrated chinks in their financial armor:

Cisco

Cisco limped through 2011. Their own analysis in their most recent 10-Q is not very encouraging:

Gross Margin

In the first quarter of fiscal 2012, our gross margin percentage decreased by approximately 1.6 percentage points, as compared with the first quarter of fiscal 2011. Within this total gross margin change, product gross margin declined by 2.5 percentage points, while service gross margin increased by 1.5 percentage points. The decrease in our product gross margin percentage was a result of higher sales discounts and unfavorable product pricing, and product mix shifts. Partially offsetting these decreases in product gross margin were lower overall manufacturing costs, higher shipment volume, and lower amortization expense from purchased intangible assets. The increase in our service gross margin was due to increased volume, partially offset primarily by increased costs and to a lesser degree, unfavorable mix impacts.

In other words, Cisco is confirming a very troubling trend:

Product shipments are trending higher, manufacturing costs are trending lower, BUT product margins are trending lower due to increased discounting.

Piper Jaffray wrote that Oracle’s Q2 results illustrate a “clearly more sluggish spending environment.” They predicted “continued unexciting growth” over the next two quarters.

The Realities of 2012

The above data is all old news. Right? It’s the New Year! Yes, it is a new year, but I do not see tech shaking this funk anytime soon. In fact, I feel it will get tougher in 2012 for the legacy providers. Even if the global economy does not falter, the financial models for tech companies will struggle in 2012. Why? Because the three most important plays in the tech company playbook don’t score easy points anymore.

Old Play #1: Next Generation Product Release

When margins start to lag, tech companies look for that next hot product release that will reinvigorate pricing points and margins. The margins on new tech products are commoditizing at alarming speeds. Look at everything from the price of an Ethernet port to the price of a tablet computer for validation of this reality.

Old Play #2: Acquire Revenue and Margin

Legacy tech companies with lots of cash on hand love to run this play. Oracle, obviously, has been very proficient at this play as pointed out in the Wall Street article:

But Piper Jaffray saw a silver lining in Oracle’s ability to “acquire companies with 10%-20% operating margins, strip out costs, and rapidly realize 40% operating margins for the acquisition targets”

On Oct. 24 Oracle said it would purchase cloud customer service company RightNow Technologies for $1.5 billion.

“As such, we remain optimistic about Oracle’s aggressive acquisition strategy, which we describe as an ‘earnings arbitrage’.”

Here is the rub: the up and coming stars in tech are not printing cash. Let’s say SAP decided to purchase Taleo to counter the Oracle purchase of Right Now. In their most recent 10-Q, Taleo posted a loss. What if Oracle decided to gobble up salesforce.com? Salesforce, which has been around for over decade, continues to lose money. I am not convinced that Oracle could purchase salesforce, strip out costs, and have a new 40% margin engine. The SaaS model is simply not yet performing at that financial level.

Old Play #3: Cut Costs

Tech companies learned from the largess of the dot com era. Over the past decade, they have become masters of cost control. Which is why there is very little upside left in this play. Unless, of course, tech companies start requiring their employees to travel “cargo class” on business trips.

Adversity Creates Opportunity

Now that I have thoroughly depressed all of my tech industry peeps, let me offer a word of encouragement. Even though I believe 2012 will be a tough year for many tech companies, I also believe 2012 will be a year of business model innovations. I promise to carry this optimism forward in my next post by commenting on some of the wonderful bright spots I see in the industry.

Both of these entries accurately predicted “the wall” Cisco would hit. This prediction was not prophetic– it was based on the realities of how the technology industry is changing and maturing. Cisco’s challenges are not about the global economy. Cisco’s challenges are all about an economic engine that can no longer be supported by the changing enterprise IT market.

You’ve seen the great results posted by Apple, but is the technology industry overall still recovering?

You’ve seen the business press lamenting Cisco’s stall, but how do their results compare to other technology providers?

Everyone says cloud computing will disrupt business models, but is the impact of cloud being felt today by technology providers?

Well, stop guessing on what is going on in the technology industry and tune into to TSIA’s quartlery webcast that reviews the actual financial performance of fifty of the largest technology providers on the planet. See how Q1 2011 compares to the data TSIA has been trending for the past five years.

In Berlin next week, I will be delivering a keynote at the Technology Services Europe conference. In this keynote, I will be teasing out the patterns that are emerging in the world of technology services. But as part of that discussion, it is important that we all understand the patterns that have already clearly established themselves in technology services. One of those known patterns, is the steady increase of service margins.

The entry spoke of the maturation of the telecom industry and the impact that maturation has on technology providers like Nortel, Alcatel-Lucent, and Cisco. In that entry, I wrote:

The Telecom industry, and product companies serving that industry, find themselves smack in the middle of a “services chasm” market as described in “Bridging the Services Chasm.” In this type of market, traditional product revenues and margins have slowed as the market has matured. Product companies in the market must decide if they will change their revenue stream by diversifying into new service lines (we call that a change mix strategy), or stay focused on being a product provider and seek new product markets to pursue (we call that a change market strategy).

The Telecom industry, and this recent prediction of revenue trends, is a perfect example to help illustrate the dynamics that play out in maturing markets. Historically, telecom equipment providers such as Lucent, Alcatel, and Nortel, have all been very product-centric companies, with the vast majority of their revenues coming from actual product sales. However, the folks at Heavy Reading are predicting a dramatic shift in revenue mix for “leading” telecom providers from products to services.

When markets mature and companies enter the services chasm, there is one type of company that is at extreme risk of failing: The Product Provider. These are companies that receive a majority of their revenues from product transactions and have a small percentage of revenues coming from services. This imbalance makes it very difficult for them to adjust to the type of shift in revenue mix predicted for the telecom industry.

Today, I read an editoral by Bob Evans in InformationWeek. The title: Cisco Zapped by Destructive Power of Innovation. In the article, Mr. Evans reports the following insights on Cisco’s current challenges:

“Sales of Cisco’s largest switching platorm slowed at the end of 2010 as the product rapidly became uncompetitive from a price and functionality perspective.”

“Cisco did finally migrate customers to its not new product lines, but at much lower margin. Ouch!”

Cisco, perhaps one of the strongest hard core “product providers” left in enterprise IT, is now facing the relentless march toward the services chasm. Find a new hot product market with better product margins, or change mix and expand service capabilities. This is the challenging choice all product companies eventually face. Even companies as well managed and execution oriented as Cisco.

This Thursday I will be delivering the quarterly review of the TSIA Service 50 data.

As I look at the Q4 2010 data, it is clear the recovery is holding for the tech industry. Top line growth is steady, and profits continue to remain strong. But what is the deal with all the cash these tech companies are aggregating? Check out the war chests being horded by some of the Service 50 companies:

Join me this Thursday for the complete Service 50 readout as well as some discussion on this emerging challenge facing tech companies: Where to invest the cash?

The article referenced some recent research conducted by Heavy Reading (www.heavyreading.com) that predicts the following trends in the telecom industry:

As network operators continue to look for new ways to reduce operating costs, telecom equipment vendors are nearing a tipping point at which the managed and professional services they provide will deliver substantially more revenue than infrastructure sales

Driven by network operators’ desire for cost savings, simplified network operations, and shorter time to market for new services, managed and professional services have become a rapidly growing business for telecom equipment vendors over the past five years. Today these services account for 35 percent to 48 percent of total revenues for leading vendors, and this figure is forecast to reach 60 percent within the next seven years.

The Telecom industry, and product companies serving that industry, find themselves smack in the middle of a “services chasm” market as described in “Bridging the Services Chasm.” In this type of market, traditional product revenues and margins have slowed as the market has matured. Product companies in the market must decide if they will change their revenue stream by diversifying into new service lines (we call that a change mix strategy), or stay focused on being a product provider and seek new product markets to pursue (we call that a change market strategy).

Revenue Mix and Maturing Markets

The Telecom industry, and this recent prediction of revenue trends, is a perfect example to help illustrate the dynamics that play out in maturing markets. Historically, telecom equipment providers such as Lucent, Alcatel, and Nortel, have all been very product-centric companies, with the vast majority of their revenues coming from actual product sales. However, the folks at Heavy Reading are predicting a dramatic shift in revenue mix for “leading” telecom providers as documented in the image below:

This mix from product revenues to service revenues is playing out in EVERY technology sector. From storage to servers to software, more and more revenue is being generated through service transactions as opposed to product transactions. This is the trend that leads product companies gasping at the edge of the services chasm. Thank you, Heavy Reading, for reiterating the reality.

Product Providers and the Services Chasm

When markets mature and companies enter the services chasm, there is one type of company that is at extreme risk of failing: The Product Provider. These are companies that receive a majority of their revenues from product transactions and have a small percentage of revenues coming from services. This imbalance makes it very difficult for them to adjust to the type of shift in revenue mix documented above.

As we look at the telecom industry, there were two major technology providers serving North America that struggled in the services chasm:

Nortel

Lucent

Nortel went bankrupt—clearly they were unable to navigate the services chasm. Lucent took a hard run up the services hill post 2001. They even hired a senior executive from EDS to lead the charge. However, the effort did little to change the revenue mix of the company. Lucent’s history is discussed in the first chapter of Bridging the Services Chasm. Now, Lucent has thrown its hat into the ring with another historically product-centric company, Alcatel, to ride out the services chasm storm engulfing their industry. Yet, look at the revenue trends for Lucent from 2001 – 2006 and then Alcatel Lucent from 2007 – 2009:

The graphs above show two critical facts:

Top line revenues for the combined companies is not really growing

Services remain a relatively small portion of total revenues

How out of sync is the revenue mix of Alcatel-Lucent with the revenue mix predictions from Heavy Reading? This is the risk all product providers face as their market matures. Pay attention Dell. Pay attention Microsoft. Pay attention Cisco. The trends pounding Alcatel-Lucent will be pounding your bottom lines. Change market or change mix. But don’t spend too much time thrashing around in the services chasm.

In Santa Clara last week, I delivered a keynote on the impact cloud computing will have on technology providers. In the section of my presentation titled “Breaking Glass”, I emphasized the emergence of “The Google Price.” The Google Price is the baseline price IT consumers will be willing to pay for commodity IT capabilities. Companies like Google, Amazon, and Apple are setting price expectations for basic IT capabilities like email, storage, and targeted software applications.

I argued in Santa Clara that for legacy IT providers to compete in this emerging environment, they would need to provide basic IT subscription services that are competitive at the Google price. Then, they would need to wrap a set of value added service capabilities around these base subscriptions. I have been making this argument since November of last year:

“The question for Cisco and EMC as they collaborate is how do they get to a price point that makes sense for customers?” said one executive for a large systems integrator that is partnering with the two giants to deliver private cloud solutions.

That’s a sensitive topic given that Hewlett-Packard, the world’s largest IT company at $124 billion, is pushing forward with its converged infrastructure (servers-storage-networking) offerings and has vowed to drive down margins both in the networking segment, where it says Cisco has enjoyed 80 percent margins, and in the storage segment, where it pegs margins at 48 percent. HP has pledged to leverage its $70 billion supply chain to pressure competitors.

A big question for solution providers looking to play in the cloud is the services opportunity that comes with the territory. “It’s all services,” said one executive for a systems integrator. “That is the only place margins are being made.”

Cloud computing will be incredibly disruptive to the current business models of IT product providers. I cannot emphasize this fact enough. Attendees at the conference last week heard my message: Smoke, Cloud, Breaking Glass.

If your company is not calculating the impact of cloud consumption models on your current business model, you have your head in the sand.

If you are not on a journey to develop value added services that augment basic technology subscriptions, you are in a race to the bottom.

If you believe your company will navigate its way through this storm on the back of product innovation, you are throwing good investment dollars at an option that is getting marginalized by the quarter.

Both of these companies are members of TSIA. Like a child in any divorce, it is wise not to take sides. So this entry is not about the split, but the current environment where this dispute is occurring. To me, that is the larger story that all tech providers should be heeding. In fact, this specific dispute reminded me of the lyrics in Dylan’s classic tune, The Times They are A-Changin’:

Come writers and critics, Who prophesize with your pen

And keep your eyes wide, The chance won’t come again

And don’t speak too soon, For the wheel’s still in spin

And there’s no tellin’ who That it’s namin’.

For the loser now, Will be later to win

For the times they are a-changin’.

So, let’s explore why the HP-Cisco split serves as a milestone marker for the more dramatic market changes to come.

Parting of the Ways: Low Stakes

The line it is drawn, The curse it is cast

The IT bloggers and analysts are thoroughly covering this split. Here is an excerpt from Alexander Wolfe’s post this week:

Here’s the money quote from the Cisco blog post, which comes via channel chief Keith Goodwin, who is senior vice president of Cisco’s worldwide partner organization:

“Over the last few years our relationship with HP has evolved from a partner to companies with different and conflicting visions of how to deliver value to customers.”

Clearly, this is a significant shift in partner strategy for Cisco and HP. However, some of the analysts are comparing this to the divorce that occurred between HP and EMC roughly a decade before. That split forced both HP and EMC to restructure their channel models after parting ways on product collaboration. The image below captures where the conflict occurred and what the impact was ongo to market models for the two companies.

The HP-EMC Divorce, Ten Years Ago

Both companies recovered nicely after the dust settled and markets were not fundamentally restructured. Perhaps this current breakup will ultimately play out in the same manner.

Parting of the Ways: High Stakes

This current divorce is playing out in a very different marketplace. Joseph Kovar from channel web makes the observation:

However, there is one key difference between the 1999 and the 2010 breakups. Whereas HP and EMC fought over how storage would be sold, they fought for their own part of that particular business.

For HP and Cisco, the stakes are higher. There is no single point of contention, such as storage, between them. Instead, they are fighting over the future direction of data center infrastructures, which has the potential to impact a wider range of technology and channel partners.

In fact, the entire go to market model for tech companies like HP and Cisco is on the cusp of a radical restructuring. Instead of the battle ground being focused on specific products and specific channel partners, the battle ground is being shifted to datacenter infrastructure and service consumption models. CIOs will not be negotiating with a reseller on how much Cisco or HP gear to purchase. A CIO will be negotiating with a service provider around the monthly or annual costs for entire datacenter capabilities. Services, routers, applications—the whole deal. This is the future Cisco and HP are now dancing around. The image below capture the new marketplace.

The HP-Cisco Dispute

The Waters Have Grown

So, it strikes me that this dispute is not like the one that occurred a decade ago between HP and EMC. The stakes are much higher. The go to market model is shifting much more dramatically. There will be big winners and big losers over the next decade.

In Barcelona this month, I hosted a panel discussion of executives from Dell, Xerox, and HP. The topic was the recent acquisitions these companies had made of pure service firms. I asked the panel if their companies intended these acquired service organizations to remain “product agnostic.” The answer from HP was clear: “No.” The other executives layered on by stating that customers were asking less about the products being implemented, and more about the total cost of the environment. This panel discussion should send shivers down the spine of any product-centric company that is being relegated to providing commoditized technology in this new market landscape.